The number of new businesses being formed in the US is near an all time low

Last month I wrote about how the US entrepreneur may soon be an endangered species due to the impending retirement of the Baby Boomer generation and the lack of entrepreneurial spirit among the new Millennial generation, who may have been expected to buy the retiree’s businesses.

Although one of the defining business trends coming out of the 2007/8 financial crisis has been a “startup boom” with many people starting an app development company or buying into a franchise opportunity, according to Michelle Meyer, US economist at Bank of America Merrill Lynch this impression, may be just an illusion.

Both the formation of firms (for example, a new “Apple” corporation) and individual establishments (an Apple store), have dropped off precipitously since the financial crisis and remained low (see the diagram below).

According to Meyer, this is important, because new businesses tend to hire faster and produce higher levels of productivity than firms that have been around for a while. So the decline in business formation might explain some of the labor market’s post-recession problems, and is at least part of the reason for the steep drop in productivity.

Additionally, Meyer says, it can end up affecting the nation’s gross domestic product :
“A recent paper from the Federal Reserve Board estimates that there is a persistent increase in both GDP and productivity as a result of changes in the number of start-ups. Specifically, they found that a one-standard deviation shock to the number of start-ups led to an increase of real GDP culminating to 1-1.5% and lasting 10 years or longer. This suggests a notable and lasting impact on the economy from weak rate of business entry over the past decade.”

Meyer suggests four reasons for this depressing economic trend:

“Tighter credit conditions.” After the recession, it was harder to get loans, especially since houses were often used as collateral for new ventures. Without capital to start businesses, the number of startups decreased.
“Uncertainty shock.” Both the recession and following political and economic battles have led to shocks that have discouraged small-business formation.
“Technology disruptions.” Before the financial crisis, many new businesses came in the form of new retail stores or new retail locations. With online sales becoming more popular, this is discouraging new establishment formation. Add a shift away from manufacturing due to technology, and it’s even worse.
“Aging economy and population.” As the US population ages, there is “a natural downward pull on business dynamism” since most entrepreneurs are young people.

It is not all doom and gloom, however. For one thing, credit access has gotten considerably easier in recent years, allowing new businesses to take out loans. Business confidence is also a cyclical trend that can be reversed.

On the other two, Meyer notes that technological disruptions can cut both ways.

As cited in last month’s newsletter, Millennials are only just hitting “prime age,” which means they now have the capital and experience to take on a business venture themselves.

“Research from the Kauffman foundation discovered that the average successful entrepreneur in high-growth industries founded their company when they were 40 years old,” the note said. “With the oldest millennial just turning 36, demographics should turn supportive for new business formation in the medium term.”

So it’s not pretty for now, but entrepreneurship isn’t dead in America……yet.